OSFI Issues Final Revised Guidance on Reinsurance Practices
On February 11, 2022, the Office of the Superintendent of Financial Institutions (“OSFI”) concluded its review of reinsurance practices by issuing final revised versions of its Guideline B-3, Sound Reinsurance Practices and Procedures (the “Final B-3 Guideline”) and Guideline B-2, Property and Casualty Large Insurance Exposures and Investment Concentration (the “Final B-2 Guideline” and together with the Final B-3 Guideline, the “Final Guidelines”). The Final Guidelines will come into effect on January 1, 2025, allowing a nearly three-year transition period for business practices to adjust to these new requirements before they come into force. The publication of these Final Guidelines concludes Phase II of OSFI’s review of reinsurance practices, initially launched in 2018 through the Discussion Paper on OSFI’s Reinsurance Framework.
The Final B-2 Guideline – P&C Large Insurance Exposures and Investment Concentration
The Final B-2 Guideline sets out OSFI’s expectations relating to large insurance exposures. In the context of reinsurance, OSFI expects a federally regulated insurer (“FRI”) of property and casualty (“P&C”) risks to be able to cover the maximum loss related to a single insurance exposure on any policy it issues, assuming there is a default of its largest unregistered reinsurer on that exposure. This guideline applies to all P&C FRIs: to insurance companies on an individual and consolidated basis and to branches in Canada of foreign insurers.
The Final B-2 Guideline reflects comments by the P&C insurance industry in response to the draft B-2 Guideline issued in November 2020 (for more information on this draft, please refer to our previous blog post).
Consistent with the draft B-2 Guideline, in the Final B-2 Guideline OSFI expects P&C insurers to have a comprehensive Gross Underwriting Limit Policy (“GUWP”) which defines what constitutes a single insurance exposure by class of insurance. Many stakeholders requested clarification on what this definition should be and OSFI’s response in the Final B-2 Guideline indicates that it will leave this determination to P&C FRIs. Furthermore, the Final B-2 Guideline removes much of the prescription that existed in the draft B-2 Guideline for determining single insurance exposures for particular classes of insurance. However, OSFI notes that it may advise a P&C FRI to use a specific approach or criteria in determining a single insurance exposure.
In the draft B-2 Guideline, the insurance exposure limit for foreign branches was initially 100% of net assets available, subject to satisfying certain criteria, and 25% if the criteria was not met. Stakeholders were concerned as to how OSFI would evaluate this criteria and as a result, the Final B-2 Guideline has been amended by removing the reference to the two different levels. As a result, the insurance exposure limit for foreign branches is simply 100% of net assets available. Furthermore, the term “P&C FRI Subsidiary in Canada” has been removed and replaced with the general term “Insurance Companies” for simplicity purposes, with maximum exposure on a single loss as prescribed. The insurance exposure limits in the Final B-2 Guideline are as follows:
- Insurance Companies: 100% of total capital available where any entity in the P&C FRI's control chain is a widely held company and/or a regulated financial institution; 25% of total capital available otherwise.
- Foreign Branches: 100% of net assets available of the foreign branch.
We note that the investment limits contained in the Final B‑2 Guideline remain unchanged from the draft B-2 Guideline. Accordingly, a P&C FRI’s aggregate market value of investments in any one entity or group of affiliated companies should not exceed:
- Insurance Companies: 5% of the value of the company’s assets reported on the balance sheet of the company’s regulatory return filed with OSFI.
- Branches of Foreign Insurance Companies: 5% of the value of assets vested in trust in Canada by the foreign company, as reported on the balance sheet of the foreign company’s regulatory return filed with OSFI.
These limits are in addition to limits set in the Insurance Companies Act (Canada), and are subject to lower thresholds or further limits in a company’s or branch’s own investment policy, such as limits based on geography or asset class.
As stated in its cover letter describing the Final Guidelines and the changes to regulation, OSFI expects a P&C FRI to be in a position to fully cover its potential losses with funds available in Canada or from a diversified panel of reinsurers.
The Final B-3 Guideline - Sound Reinsurance Practices and Procedures
The Final B-3 Guideline sets out OSFI's expectations for effective reinsurance practices and procedures. This guideline applies to all FRIs (both domestic P&C and Life insurance companies and foreign P&C and Life insurance companies in respect of their insurance business in Canada, both P&C and Life registered reinsurers, and fraternal benefit societies) that are party to reinsurance cessions, retrocessions and, where applicable, to assumption reinsurance transactions. The Final B-3 Guideline is substantially similar to the draft B-3 Guideline issued in June 2019, except for a small number of additions noted below with regards to insolvency clauses in reinsurance contracts.
The Final B-3 Guideline notes OSFI’s expectation that FRIs have a “sound and comprehensive” reinsurance risk management policy (“RRMP”) that is overseen by senior management and reviewed annually at a minimum. The RRMP should set out elements such as the purpose and objectives for seeking reinsurance, ceding limits, counterparty risk and concentration limits.
In the Final B-3 Guideline, OSFI recognizes that reinsurance can be a key tool for mitigating and managing insurance risks but notes that FRIs must regularly assess the adequacy of their reinsurance arrangements (e.g. through stress testing) in accordance with their risk appetite. OSFI also notes that the RRMP should establish appropriate ceding limits and that FRIs should not in the normal course of business cede 100% or substantially all of their insurance risks. While OSFI does not explicitly provide a definition of “substantially all”, it does note in the Final B-3 Guideline that this term would be generally applied in a manner consistent with that used in the context of assumption reinsurance and asset sale transactions, which is generally 75% or more. However, we note that OSFI has noted in prior commentary on a draft guideline B-3 that its approach to the question of when “substantially all” of assets are transferred is to be principles-based, from the perspective of an insurer’s entire business. Accordingly, insurers may be able to cede up to 100% of individual risks or blocks of business in certain circumstances.
As provided in the Final B-3 Guideline, OSFI expects that FRIs will also consider counterparty risks when establishing ceding limits and are expected to perform due diligence on their reinsurance counterparties on an ongoing basis to ensure that the FRI is aware of counterparty risks and is able to assess and manage such risks. The level of due diligence should be commensurate with the level of exposure to the counterparty and FRIs should not solely rely on third parties (e.g. rating agencies) to perform the due diligence.
In order to satisfy OSFI’s stated expectations in the Final B-3 Guideline, FRIs should also ensure that the terms and conditions of reinsurance contracts provide clarity and certainty on reinsurance coverage, and that there is a written final agreement of all material terms prior to the contract’s effective date.
Most of the changes from the draft B-3 Guideline to the Final B-3 Guideline are with regards to potential insolvency situations and applicable language in reinsurance contracts. The Final B-3 Guideline specifies OSFI’s expectation that, regardless of whether the reinsurer is in the same corporate group as the FRI-cedant, all reinsurance contracts include an insolvency clause that makes it clear that the reinsurer must continue to make full payments to an insolvent cedant, or to a person acting on the insolvent cedant’s behalf in Canada, without any reduction resulting solely from the cedant’s insolvency. OSFI is looking for insolvency clauses to specify that reinsurance receivables remain within the general estate of the insolvent ceding company, or as part of the assets in Canada of a foreign insurance company as defined under the Winding-Up and Restructuring Act and the Insurance Companies Act, rather than being allocated for the payment of specific creditor or policyholder claims.
Overall, OSFI expects an FRI to maintain the following documentation and may request an FRI to provide such documentation to OSFI:
- its RRMP;
- a complete description of all its reinsurance arrangements;
- the due diligence performed on reinsurance counterparties; and
- the stress testing performed on the reinsurance program.
In addition, as good corporate governance, OSFI expects that:
a) FRIs will report to their senior management that the FRI’s RRMP satisfies the principles in Final Guideline B-3, except as may be disclosed, including assurances that there have been true transfers of risk which have been accounted for in an appropriate manner;
b) where there have been any deviations from the principles in Final Guideline B-3, these will be disclosed to OSFI, including the nature and the extent of the deviation, including measures taken or proposed to be taken to correct or mitigate risk resulting from the deviation; and
c) an FRI will promptly inform OSFI it is becomes aware of an issue with reinsurance that could have a material effect on the FRI’s financial condition.
As noted above, the Final Guidelines come into effect on January 1, 2025. FRIs should continue to comply with the current Guideline B-3 and Guideline B-2 until January 1, 2025. The three-year transition period will give FRIs time to adjust their business practices to comply with the new Final Guidelines before they come into force. OSFI will also be holding industry information sessions in the coming months to provide additional clarity regarding OSFI's expectations and supervisory approach.
By strategically leveraging our deep industry expertise, our market-leading Insurance & Reinsurance Group enables our clients to traverse Canada’s complex, highly-regulated insurance environment. Please contact Nancy Carroll or Hartley Lefton if you have any questions or for assistance, including for assistance in complying with the Final Guidelines before they come into force.